A blog dedicated to real estate matters, finance as well as general economics and political economics issues. Posts written by Luigi Frascati, B.Econ. Your comments and suggestions are appreciated.

Thursday, March 16, 2006

Real Estate Bernankenomics

Further to my post entitled "Breaking the Real Estate Bubble Myth" published here first on December 29, 2005 (which has gotten me an interview on local TV), here are some additional reasons as to why the 'bubble' is not going to burst any time soon...

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Sure, prices are high and that’s the way most of us property owners want them to be. Whether you made your purchase a long time ago and are now staring at your equity ecstatically, or you just completed your purchase yesterday and are now watching CNN with trepidation for news of bubbles dropping off the sky, the fact of the matter is that most of us have a vestedinterest in seeing to it that housing values remain high.

And so does Ben Shalom Bernanke, the new Chairman of the Federal Reserve System.

Ben Bernanke knows he is filling big shoes. So when President Bush chose the White House’ relatively new top economic adviser to succeed Alan Greenspan as the new Fed’s Chairman, Bernanke professed alignment with the Maestro by declaring that the ‘top priority’ under his tenure would be to ‘maintain continuity’ with Greenspan’s way of doing things. And Prof. Bernanke is living up to his promise, thus far.

Bernanke, who was named Chairman of the President’s Council of Economic Advisers after serving on the Fed’s Board of Governors for three years, believes in a predictable approach for fighting inflation. To lessen the possibility of a surprise that could create panic, Bernanke’s view is that it is paramount for financial markets to understand what the Fed is doing. Thus he has argued for picking a target rate for inflation, and has made clear that the Fed will cut interest rates when inflation falls below the target. Bernanke’s target for 2006 is about 3 percent for the Consumer Price Index.

Furthermore, the new Chairman has outlined the two main responsibilities of the Fed under his chairmanship: to fight inflation and to foster orderly growth. More specifically, and this is of paramount importance for the real estate industry, Bernanke has a much softer view on prices rise than his predecessor. So much so, in fact, that when the economy was threatened with deflation a few years ago, Bernanke was the most vocal among all Fed’s Governors about the need to generate inflation by cutting interest rates to stimulate spending. Given the choice between fighting inflation or foster growth Bernanke, unlike the Maestro, will likely opt for growth.

Seen in this light, the facts that U.S. consumers have too much already and want more, that they do not save enough, that the trade deficit is too large and bound to become even larger and that the American economy is far too dependent on housing – all points cited by scores of ‘bubbleologists’ whose ranks now seem to be thinning out more and more every day – all these facts do not get all the head attention anymore, at least for the moment. It is certainly true that consumers nowadays, both in the United States and Canada, are more indebted than ever before. But much of this debt is anchored on the built-in equity of real property assets, which thus far has been steadily growing. So therefore, to make the monthly debt burden onerous enough to cause a bubble to burst - that is a cascade of mortgage defaults with a flood of foreclosures on the market, which in turn would bring prices down - one would have to look not to higher interest rates but, rather, for a big drop in family income. As monthly debt payments remain the same, a drop in income would quickly dry up the cash reserves of many consumers, so that the predicted avalanche of mortgage defaults would start rolling down.

But any such scenario would require not only an economic slow down caused by higher interest rates but, rather, an outright recession. And this is nowhere happening in the economy, certainly not with globalization moving full ahead. Both the United States and Canada, in fact, are forecasting expanding economies for 2006 with an anticipated GDP of 2 percent and 2.5 percent respectively. Therefore, it would certainly appear that those who are expecting a real estate market bubble – or are hoping for one to come – have much longer to wait than they originally anticipated.

Which in turn means for all those ‘bubbleologists’, Sunday-afternoon crystal ball readers and part-time economists out there, I hate to have to say this but … I told you so!